More of the Same Won’t Cure Housing Hangover

Posted by Jim DeBellis on June 1st, 2011

As the news just keeps on getting bleaker, the blame game is swinging into full gear. Some are calling it a failure of capitalism, others blame greed, while still others put the cause squarely on the shoulders of the government. For me, everything points to moral hazard.

Moral hazard simply means that there is no need for accountability, as if you had free insurance on everything. If you fail, you will get bailed out. So, you either win big and make billions, or you lose big and the government pays you billions to cover your losses. What a deal. But it’s not really the government bailing out big banks and corporations; it’s the taxpayers. Fannie Mae and Freddie Mac, once “private” quasi-government agencies but now owned by taxpayers and controlled by government, guarantee 90% of all mortgages. The lender can’t lose, as they just sell their paper to the government on the secondary market (Fannie and Freddie).

You would think that the housing crash would have made them tighten their standards, but that hasn’t really happened. Banks can give mortgages to anyone with a FICO credit score above 620 – a number considered “poor” or “risky” by most scales – and Fannie and Freddie will buy it. The “hair of the dog that bit you” may be a good hangover cure for drinking (have a shot of vodka to cure a vodka hangover or a bottle of beer to cure a beer hangover), but it is not working so well with the housing hangover since the bubble burst.

In fact, trying to cure the housing debacle with the same risky loan guarantees that caused the problem is making things worse, as yesterday’s dismal housing index report indicated. Housing values have reached their lowest point in four years and are declining at a rate of 11 percent annually. Still, as low as prices seem to be now, they are still well above the average price for a home since 1970 when adjusted for inflation, according to the New York Daily News. Some experts are planning to stay out of the housing market until an average three-bedroom home is selling for two to three times the annual salary of an average worker.

But, with the government guaranteeing nearly all mortgages, prices will remain artificially higher than they would be without government intervention in the market. It seems likely that government will have to wean the housing market off of its support system over the next decade if the broader economy is to recover. Capitalism, like nature, can’t really fail when left to its own devices – but it can be brutal and painful. Still…a little pain might be just what the doctor ordered to cure this hangover.